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9/30/03
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Capital
Expenditures: What
to Consider before Investing
Written
by:
Shana Martin, SCRC
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As
consumers continue to take advantage of low interest
rates for mortgage, vehicle and other personal
loans, the business community is receiving mixed
signals about the environment for capital spending.
Currently, the Federal Funds Rate (FFR) is at
a 45 year low of 1 percent. This low rate in the
FFR lowers the cost of borrowing between financial
institutions. This decreases interest rates across
the board, and the resulting short- and long term
borrowing costs are at levels not seen in 60 years.
(1)
Economic Indicators
Current economic figures show improvements over
previous quarters. Among the high points are:
| • |
Economic
growth achieved 2.4 percent in the second
quarter, an increase from the 1.4 percent
seen in the past two quarters, according to
the U.S. Department of Commerce. |
| • |
Business
investment increased 6.9 percent in the second
quarter, representing the best increase in
three years, according to the Commerce Department. |
| • |
The
Federal Reserve reported that in July, industrial
production went up by .5 percent, the largest
increase since January of this year. |
| • |
July
factory output increased by .2 percent, the
third consecutive monthly increase, according
to the Fed. |
Other Considerations
The considerations preventing companies from further
investment include demand concerns, capacity utilization,
and the current business environment. For new
capital spending to be justified, there needs
to be a reasonable assumption that demand will
increase. Additionally, given the market wide
increase in demand, companies need to see this
upswing as sustainable, not a temporary change.
Industrial
capacity utilization is still low. This indicator
measures the percentage of the nation's productive
capacity that was employed during the month. The
long-term average is around 82 percent; currently
the average is only 74 percent. (2) Without an
increase, there is little reason for businesses
to expand.
As
for the current business environment, accounting
scandals and general uncertainty have put executives
on guard. Rather than spend money in areas such
as capital expenditures in an unpredictable market,
executives are focusing on their balance sheets
and eliminating liabilities, including long-term
debt. (3)
Some economic experts say that capital expenditures
will have to pick up soon, if for no other reason
than replacement. They predict that with the rate
that equipment is wearing out, an increase in
spending will have to occur once demand improves.
During the past year, the ratio of depreciation
to new capital spending was the highest it has
been since World War II. (1)
References:
(1) Cooper, James and Madigan, Kathleen. The Economy
gets Some Get-Up-And-Go. Business Week, August
4, 2003. pg. 25-27.
(2) Stone, Amy. Behind the Surge on Capital Spending.
Business Week Online, August 14, 2003
(3) Cooper, James and Madigan, Kathleen. The Fed's
Biggest Headache: Corporate America, Business
Week, 10/7/02, page 37.
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